With the fallout from the huge losses at the bank JPMorgan being felt around the globe, it is clear non-executive directors of banks should exercise more scrutiny, and that if they had ‘skin in the game’ they would be more cautious about taking huge risks.
America’s biggest bank, and its high-profile CEO and Chair, Jamie Dimon, have announced trading losses on its derivatives position in bonds in excess of $2 billion. The blunder on risky derivatives trading has caused mammoth losses which have marred JP Morgan’s reputation for risk management – and have once again thrown a spotlight onto corporate governance, and investment banking.
Chief Investment Officer Ina Drew, who was among the highest-paid executives at the bank, will now be succeeded by Matt Zames, a trader who is well versed in risky financial bets. He was at one time employed at Long-Term Capital Management, a hedge fund whose 1998 collapse nearly caused a global crisis.
If it turns out to be anything like the disaster at ‘Long Term Capital’, unwinding its position could prove both time-consuming and very expensive. It is far from an isolated example of rogue trading. Despite having survived the Sub Prime Loan and GFC crises relatively unscathed with Jamie Dimon emerging as a hero, JP Morgan has been taking high risks with its huge bond portfolio, only 30% of which is in federally guaranteed bonds. This compares with Bank of America with 87%. JP Morgan also has depositors funds of $1,127,806 million reported in its 2011 accounts. This is reflected in its 25% return on equity of $6.5 billion. It is clear the bank is highly leveraged and has gained high returns on its equity until recently – but with high returns comes high risk. Not surprisingly, there are calls for the reintroduction of the Glass-Stegall Act that until recently separated deposit-taking banks from investment banks that take their own risky principal positions.
I have conducted research which indicates that large boards dominated by non-executives with very little of their own cash invested, pay management excessively and give far too much reign to the CEO.
JPMorgan displays all the signs of a bank dominated by one man, Jamie Dimon, who rightly or wrongly is perceived to be a hero. He reports to a huge 12 person board made up of 11 non-executive directors and he is also the chairman. Generally, in these sorts of firms, there is also very poor alignment between the interests of shareholders and management. In this case, the problem is compounded by Jamie’s dual role. The overall performance of such boards is also generally exceedingly poor. This poor performance is also borne out by top 200 companies listed on the ASX that have large boards relative to those with smaller boards in which directors have more ‘skin in the game’. Quite simply, smaller boards are better able to see what is going on and work out the risk, and directors are forced to take more responsibility for decisions made collectively by the board. If they also invest their own money, they are more cautious.
Peter Swan is a professor of finance at the Australian School of Business, University of NSW.